In a recession, cash is king. All the more reason, then, to make sure that your company is taking proactive measures to avoid paying more tax than is necessary.
As the downturn deepens, the Government's tax policies are seldom very far from the headlines. The broad brush strokes are well known: tax cuts in the short term to stimulate the economy, followed by the sharp increases necessary if the Government is to repay its borrowing and balance the nation's books.
Faced with the double whammy of a slowing economy coupled with the prospect of rising tax bills in the future, British companies should be making sure that they are not handing over more than they should to HM Revenue and Customs (HMRC). Indeed, as Kevin Phillips, International Tax Partner at Baker Tilly, points out, in the current economic climate UK companies should be placing increasing emphasis upon tax planning.
"It's not necessarily something that is at the forefront of CFOs' minds in a downturn," he admits. "But there are some very good reasons to look at ways to reduce the tax burden on your company."
First, it is good practice to ensure that as much cash as possible is retained within your business, so taking measures to cut your tax bill contributes towards this aim. This is particularly important when the economic climate worsens, not least because companies often find that, as revenues decline, tax payments take up an increasingly large proportion of their profits.
For instance, multi-national companies typically find that, even in a global recession, some territories perform better than others. "Your UK operation may still be making a profit, while overseas businesses post losses," says Phillips. "One result of this is that you're paying taxes on the profits, but not getting any relief for the losses."
Then there's the fact that while profits fall, spending does not necessarily fall in proportion. This too can have a major impact on your effective tax rate. "Groups have non-tax deductible expenses," explains Phillips. "If these stay more or less constant, but revenues decline, then tax as a proportion of earnings goes up."
All of this underlines the importance of embracing tax planning as part of the wider process of steering a business through difficult times. So what exactly can be done? Click on the headings below for details.
Taking action
It is important to remember that the measures required are not always straightforward. Take the question of claiming relief for overseas losses. This was the subject of a protracted battle between Marks and Spencer (M&S) and the taxman, with the retailer fighting for the right to claim relief in the UK for losses made abroad.
The company had set up stores in Europe, which it was forced to sell or close. Unable to claim loss relief under UK tax law, the company challenged the UK authorities on the grounds that this was contrary to the EU Treaty. Ultimately, the European Court of Justice ruled that M&S could offset its overseas losses against UK profits, provided there was no possibility of relief in other member states.
"Since the M&S case there is some scope for companies to get relief for foreign losses," says Phillips. "However, the conditions are very onerous in that you can't really offset the amount lost unless the subsidiary has closed down."
The upshot is that where businesses are facing continuing overseas losses, although the M&S case may provide a way for businesses to alleviate their tax burden, the current tax rules are onerous and may act as a disincentive to keep subsidiaries open. However, under pressure from the European Commission, Britain may be required to relax its rules further to make relief easier to claim. Phillips says businesses should take advice and, if appropriate, prepare to make a claim now.
Company structure
An alternative in these circumstances is to reorganise multi-national operations to ensure as much profit as possible is taxed within a single jurisdiction. For instance, a British manufacturer may set up distribution companies across Europe, with each buying goods from the parent and selling them on in the home market. Under this arrangement, the overseas subsidiaries are each subject to the tax regime of the jurisdiction they are located in. This can create a situation where the UK parent company can't claim relief for overseas losses against UK profits. But if ownership of the goods is retained by a parent and a subsidiary's role is limited to earning a commission for facilitating the sale, more of the profit will arise in Britain and be taxed by HMRC.
"The advantage is that this minimises the risk of 'stranded' tax losses. It's effectively a way of consolidating the taxable profit," says Phillips.
Changing the legal relationship between group companies may sound relatively straightforward, but there is a caveat.
"To be effective, you really do have to change the commercial relationship between group companies too," says Phillips. There is also a risk that in changing the legal and commercial relationships, you get a disposal of intangible assets that will generate a tax charge, so advice is necessary.
Multi-national groups may also want to take a closer look at the tax implications of any financial support they are providing to overseas operations. For example, loans can be an expensive option. "If a parent gives a loan to a subsidiary, the taxman will want to see interest being paid," says Phillips. "That may create additional, unrelieved losses in the subsidiary, while the interest received by the parent will be taxable, and you may get witholding tax leakage too."
It's often a more tax-efficient option to convert the loan to equity in these circumstances.
Housekeeping and forecasting
Of course, all businesses should be looking at the relief available within their own jurisdiction. In many countries, including the UK, a company that makes a profit one year, but falls into the red in the next, can carry back the loss, and even get a partial tax repayment on account ahead of a tax return being filed.
Equally, a number of countries, including the UK, offer enhanced relief for research and development, including the possibility of a cash repayment from the tax authorities. However, each country's rules are different.
"For example, in Italy, there is no facility to carry back losses," says Phillips, "and in many countries, unlike the UK, there is a time limit on how many years tax losses may be carried forward."
Good forecasting is also vital in a downturn, not least because CFOs need the intelligence so they can respond to situations before they become critical. However, accurate forecasting can also help you reduce your company's tax bill.
"In the UK, companies pay tax based on forecasts," explains Phillips. "So if your finances slump and you modify your forecasts, there is scope to reduce payments to HMRC. The same applies in some other territories too."
Careful tax planning can make more cash available, which could prove a vital lifeline at a time when profits are down, customers are slower to pay and banks have tightened their lending criteria.